December 10th, 2008 by Hiland

October 6th, 2008 by Hiland

I am not an economist, but I’ve been listening and reading to as much information on the current crisis as I can understand, and I’ve finally formed an opinion of where things are, and where they are going.

So the meltdown started with the sub-prime crisis.  There, mortgages were being loaned to people that could never pay them back, and they pushed the price of homes higher and higher over a period of about 7 years or so.  The mortages were sold all over Wall Street as securities, and were made to look like good investments, so lots of people were buying them.  As people stopped being able to pay their mortgages and home prices fell, these securities tanked, and started to make financial institutions fall, like Bear Sterns in March.

However, this just gave way to a larger, more nasty problem, described in great detail in the most recent episode of This American Life, which I encourage all of you to listen to here. The gist of the problem is that this type of insurance popped up called “Credit Default Swaps”, and they are totally unregulated.  Essentially, everyone on Wall Street took out swaps on bonds that they didn’t even have, and created this inflated, non-existent market that worked alright until the insurance these swaps promised had to be called into play.  What called them into play?  The tanking of a financial institution or three.  These are what are leading to the gigantic losses that we’ve been seeing.  The swap market is estimated to be around $60 TRILLION dollars.  That $700 Billion bailout package looks pretty tiny all of the sudden, huh? 

The thing to take away here is that a lot of this money is built on fake, non-existent capital.  It’s bets on top of bets on top of bets.  

So that’s my understanding.  Now, I’ve been watching the Dow drop just like everyone else lately, but then just today I went to look at a graph of the Dow since the beginning> (Wikipedia has it here, if you can’t see it above.)  The thing that really strikes me is just how quickly the Dow grew to it’s current levels.  Looking up to the 90’s, there’s a pretty gradual curve.  Then it skyrockets, going totally nuts in the late 90’s and into 2000, and then going to historic levels early last year.  If I were actually an economist, and knew how to do it, I’d find a way to cut this graph down to the growth that wasn’t this fake capital that I described above.  I bet if i did that, you’d see the same sort of gradual growth to this curve that existed before, because that is where it is supposed to be.  There is a lot of growth that isn’t based on anything tangible, anything real, and that’s the part that is being cut out of the market right now, leaving only the good, real stuff.

Now, the rest of the tangible market has grown nicely-  there are new, real places for growth, like the technology sector, so their should still be growth from 1995 when the market (according to the above graph) was at around the 5,000 mark, but it shouldn’t be this exponential growth we became used to in the 90’s.

Again, I’m no expert here, but I think when you cut out the fake wealth, and look at the real, tangible growth, the market isnt’ up around 10K.  The market, had all this fake wealth never existed, should be around 7,500.  That’s where the Dow is going to end up before it starts to truly grow again.  Looking at the past couple of months, it may get there rather quickly, but things such as the bailout may actually delay this.

Right now, my fledgling 401K is mostly invested in mutual funds, which is supposed to be a no-no for young people, because mutual funds are safe but don’t grow as quickly as stocks do.  Since I have time, I’m supposed to be invested heavily in stocks because I can survive downturns.  However, I’m staying in the much safer mutual funds until the market drops to the 7,500 area, which is, as best I can tell, where the market really belongs in the first place.

Again, I’m no economist, but that’s my view at the moment.  The fat is being trimmed from Wall Street, and the Dow will not return to levels above 10K for 5+ years, and frankly had we never engaged in any of this unregulated BS, that’s probably about when we should have been hitting 10K to begin with.

I welcome comments.